The EU’s sustainable finance rule book comes under fire

As money has flooded into funds branded as “sustainable”, there’s been rising concern that some providers have been slapping that label on products that don’t deserve it. And as regulators all over the world come under pressure to tighten standards in response, the EU authorities have been leading the charge.

But as I outline below, their landmark disclosure rules for institutional investors have garnered widespread complaints. Paul Tang, the MEP who helped design the rules for the European Parliament, tells me they face a “credibility and greenwashing problem”.

For a hot take on the ESG wars on the other side of the Atlantic, don’t miss Gillian’s latest column, in which she argues that the Republican anti-ESG campaign risks hurting business confidence.

Tomorrow Gillian will be speaking to Stuart Kirk, HSBC’s contrarian ex-head of responsible investing, as he returns to a Financial Times stage following that Moral Money Summit speech in which he played down the financial risks of climate change.

That looks set to be one of many highlights of this year’s FT’s Weekend Festival. It’s not too late to sign up online or in person for a day of debates and performances in London’s gorgeous Kenwood House gardens. As a Moral Money subscriber, you can claim £20 off your festival pass using promo code FTWFxNewsletters at: ft.com/ftwf. (Kenza Bryan)

Investment in developing countries is essential to tackling climate change and global inequality. Yet for ESG investors, social challenges, governance flaws and poor data can be obstacles to including emerging market companies in investment portfolios. This is the topic of our next Moral Money Forum report. In your ESG investment strategies, are you directing less capital to emerging market companies — or avoiding them altogether? What are the obstacles to allocating more capital to companies in these markets? And what compelling research and data have you seen that might inform our reporting? Share your thoughts here.

Greenwashing fears for EU’s SFDR

The EU’s rule book on sustainable investing, introduced last year, was meant to bring groundbreaking transparency to the descriptions of asset managers’ funds.

But it faces a number of teething problems — notably that some disclosure requirements draw on data that either does not yet exist, or that companies will only be required to publish from next year.

Under the latest Sustainable Finance Disclosure Regulation (SFDR) rules, a fund can be classified under one of three categories: Article 6 (sustainability is not a significant factor in the investment process); Article 8 (the fund promotes environmental or social characteristics) or Article 9 (the fund pursues specific environmental or social targets). Asset managers must also publish information on how they take sustainability risks into account across their business.

Investors have said they cannot yet fully meet these disclosure requirements because some important information — for example, data on companies’ hazardous waste production, the proximity of their assets to biodiversity hotspots, or even the proportion of assets aligned with the EU’s green taxonomy — is not yet consistently published by the companies they invest in.

Paul Tang, a socialist MEP who was the lead rapporteur for the European Parliament on SFDR, told Moral Money that the regulation has strayed too far from its intended purpose of increasing transparency, and instead has inched towards being used as a marketing label. “It now faces a credibility and greenwashing problem,” he said. “We should introduce minimum requirements to make sure if an investment is labelled as sustainable it is indeed sustainable — if you say you’re green, show you’re green.”

Investors have told sustainable finance trade body Eurosif that classifying funds as Article 8 or 9 leaves them open to accusations of greenwashing. They fear that clients could interpret this classification as a bold claim for a fund’s sustainability credentials — something they’re increasingly nervous about, because of the insufficient level of disclosure by many of the companies they invest in.

“The cart was put before the horse,” Hugo Gallagher, senior policy adviser at Eurosif told Moral Money. “If you are a compliance officer, you’re scratching your head.”

The first set of companies due to publish ESG data under the EU’s corporate sustainability reporting directive — listed companies with more than 500 staff — will not be required to publish until 2024.

The head of asset management at the European Commission’s financial services division warned last year that the SFDR classification could be straying beyond its intended purpose and “becoming a kind of label”. The categories create additional disclosure requirements but do not provide a guarantee of minimum standards.

More than a third of EU-domiciled funds by value — worth €4.2tn — are classified as Article 8, with a further €470bn in Article 9 funds, according to the most recent data by research provider Morningstar.

“Everyone wants to have their product designated as article 8 or 9 . . . But if this creates the impression a product is sustainable, this could lead to issues later down the line,” Eurosif’s Gallagher said.

The uncertainty has led politicians to pressure the European securities regulator (Esma) to call out inconsistencies between marketing and reality, as the SEC has started to do in the US. An amendment to fund regulations put forward by MEPs, including Tang, and due to be debated this month, would allow Esma to call out “materially deceptive” marketing of funds.

Regulators are also homing in on the benchmarks used by passive ESG funds, which have been booming along with the rest of the sustainable investment market.

The EU has previously laid out some guidelines for green benchmarks, with rules for indices labelled “Eu Paris-Aligned” or “Eu Climate Transition”. These represent €80bn ($79.5bn) in assets and have grown to a 15 per cent share of the passive ESG fund market since they were created two years ago, according to Morningstar.

They have also been used to help improve how SFDR is implemented. Funds which have carbon emissions reduction as an objective under SFDR’s Article 9, for example, should track one of the two benchmarks, according to an Esma Q&A on interpreting the guidelines.

The European Commission declined to comment. But Esma has recently come out backing the idea of an EU-defined ESG benchmark, in a letter that warned vague benchmark naming conventions such as “Paris aware”, used by some private sector benchmark providers, can facilitate greenwashing.

This idea has sparked resistance from those index providers. Dan Kemp, chief investment officer at Morningstar, said an official EU ESG benchmark would likely rely on an exclusion approach, which could have the effect of reducing choice for professional investors without solving SFDR’s clarity problem. “If you have a single way of thinking about investment that is quasi-endorsed by the regulator . . . you are likely to have benchmark providers coalesce around one way of thinking on ESG,” he told Moral Money.

Anne Schoemaker, head of ESG products at the data and index provider Sustainalytics, told me the EU should stick to improving disclosure requirements and comparability across funds, products and indices rather than looking to regulate benchmark providers.

“Reforming SFDR [the EU’s green rule book] is too big an ask, but tweaking it and improving it is necessary,” she said. (Kenza Bryan)

Smart read

• Here’s another interesting contribution to the debate over the rising tensions in the US around ESG investing, from Witold Henisz of the University of Pennsylvania’s Wharton School. He argues the “anti-woke” movement is trying, with some success, to promote the idea of a “false equivalence” between investment strategies that consider ESG and those that don’t.